Most serious participants that go through this process take eighteen to twenty months to get to step four, but consider what you have accomplished. You have $1,000 cash and no debt except for your home mortgage. What an awesome feeling! Now that all of your payments are gone, except for the house, this step in the process should sail along.
A fully funded emergency fund covers three to six months of your expenses. So you need to ask yourself what it would take for you live three to six months if you lost your income. For most families, this amount is between $5,000 and $25,000.
So how do you determine how many months worth of expenses to use for your emergency fund? It depends how risky your situation is. For example, if you earn straight commission, are self-employed, your job is unstable, or there are chronic medical problems in your household, you should use the six-month rule.
If you a have a good, steady, secure job and have been with that company or government agency for fifteen years, you could lean toward the six-month rule. I would tend towards the six-month rule because recent events in the economy have shown us that what we thought were secure jobs are being eliminated right and left.
Money magazine reported that 78 percent of us will have a major unexpected event happen to us in the next ten years. And a poll in Parenting magazine said that 49 percent of Americans could cover less than one month's expenses if they lost their income. Can you imagine what it would feel like to have no payments except your home and $10,000 in the bank just for emergencies?
The definition of an emergency is so important, that I want to go over it again. An emergency is something you had no way of knowing was coming, something that has a major impact on you and your family if you don't cover it. That includes paying insurance deductibles, a job loss or cutback, bills from accidents or a blown transmission in a car that you need to create income.
- Something on sale you 'need' is not an emergency.
- Fixing the fishing boat is not an emergency.
- Wanting to start a business is not an emergency.
- Wanting to buy a new car is not an emergency.
- Telling yourself you need a vacation is not an emergency.
- College tuition is not an emergency.
- Prom dresses are not emergencies.
Before using your emergency fund, calm down and sleep on it first. If you are married, discuss it with your partner and you both need to be in agreement before the fund is used. By stepping back and discussing it, you can better determine if the situation is a rationalization, a reaction, or a real emergency.
Since this fund is also there to provide peace of mind, unless both partners are in agreement there will not be peace in your household. One of the biggest reasons for divorce and abuse in this country is over money disagreements. You will find one of the great side-benefits of this program is that by the family having to work together to achieve this goal, you will find a closeness and peacefulness in your household you didn't know was possible to have.
Remember that the emergency fund must be liquid so that it is easy to access. While earlier I described how I have mine setup, some people prefer to put it into a Money Market account with no penalties and full check writing privileges. If you do some research, you can find financial institutions that pay interest equal to one-year CDs. Be aware that the FDIC does not insure mutual-fund Money Market accounts, but I've not heard of one failing yet.
Wanting to buy that first home
For those of you who are still renting, you are totally debt free and probably thinking about buying a new home. As tempting as it might be, don't start saving for the down payment on the house until you have finished building a six-month emergency fund. There is nothing that can create emergencies like owning a house can. As much as I try to budget for all the maintenance necessary, something is always needing repaired.
There are many people at this point that are so good at being the masters of their money, that they decide to try and save up the entire cost of a house and buy it outright. After all, if you have no payments other than basic living expenses, you can save up pretty fast. As I discussed earlier, if you can't wait, use the fifteen-year mortgage plan with payments no more than twenty-five of your take-home income.
And save up a few thousand for extras that are always needed once you move in. After all, new wood floors or curtains are not emergencies and you need to budget for them. This will keep you from being stressed-out and how can you enjoy what you have worked so hard for if you are stressed-out?